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June 24, 2013

Can Germany’s Economy Continue to Prop Up Europe?

Whether or not Germany, as some recent news articles have suggested, has been disinclined to acknowledge its leadership role in Europe’s prolonged economic crisis, it is no great secret that the country has been Europe’s backbone over the past years.

Naturally, this has been and still is a huge burden to take on, one that would be best shared with at least one other country. But even though Europe is slowly hobbling forward now, Germany continues to play a pivotal role in the continent’s healing process particularly given the weakening state of the French economy. And though recent economic forecasts have highlighted some wear and tear on the German economy (the International Monetary Fund revised its GDP growth forecast for the Germany economy this year from 0.6% to 0.3%), experts incuding Anatoli Annenkov, senior European economist for Europe at Societe Generale in London, are nevertheless positive on Germany’s resilience thus far and its ability to continue carrying the load.

“We have taken a generally positive view on the German economy, although we had expected a fairly stronger rebound in Q1 this year,” Annenkov said. “Although private consumption has been driving growth, Germany did experience negative headwinds from the recession in the rest of Europe and several uncertain factors that happened over spring, like the Cyprus bailout, and these, combined with unusually cold weather, did have effects on Q1, but should lead to a rebound in Q2.”

Overall, of course, second half growth for Germany will be low at a forecasted 0.3%, but this “fits into the general image of Europe,” Annenkov said, where economic recovery is happening slowly. But Germany continues to have more resistance than other countries in Europe, he said, not least because its exports are more diversified than those of other countries. “So if the US is recovering, as we do expect, then Germany’s export sector should improve in the second half,” he said.

In fact, Germany’s greatest strengths have much to do with its highly competitive export sector, Annenkov believes, which generates healthy external surpluses, and a well-balanced fiscal framework that has resulted in sound public finances. In addition, Germany avoided building up excessive private sector debt and reformed its labor market in the last decade and this has given the economy a strong foundation.

“The challenges will be to maintain these comparative advantages, especially in light of a rapidly aging society – something that will require ongoing reform efforts,” Annenkov said.

Germany’s aging society is one of the greatest challenges to the economy today, according to Holger Sandte, chief European analyst at Nordea in Copenhagen. Over the next decade, “Germany will lose five or six million people of working age, and this is going to be a huge problem,” he said.

Immigration from Southern and Western Europe will help: Last year, more than 350,000 immigrants relocated to Germany, among them young people from Spain, Italy and Portugal where unemployment is still staggering, and German companies are also actively recruiting skilled workers from these countries, Sandte said. But immigration is also a highly contentious issue, particularly in tight economic times, so as much as Germany may need outsiders to help rejuvenate its population, the social debate that includes changing views on immigration is a broad and extended one that won’t happen overnight.

On a more immediate note, energy prices are also a challenge for German economy. “After the Fukushima nuclear disaster, [Chancellor Angela] Merkel decided that Germany should exit nuclear energy after 10 years, and although Germans agree as citizens, their energy bills are clearly much higher, and that has an impact on the purchasing power, which in turn impacts the private consumption and how it drives the economy,” Sandte said.

Still, despite the broader Eurozone recession (and clearly, Germany would be better off its European neighbors were in better shape, since the economy is dependent on demand from other countries within Europe to fuel its exports), Germany remains the strongest economy in Europe and is likely to remain so. While the recent floods in Germany are likely to be costly to the insurance sector, they could also lead to some fiscal stimulus for reconstruction, which Germany has room for – something, according to Annenkov, that would mitigate the impact of the broader Eurozone crisis and the recession on economic growth.